Jim: I have a client that is selling some property and the real estate agent suggested a “lease purchase” but I think a land installment contract would be better.

Kerrie: Okay, I’ll play “devil’s advocate.”

Jim: Is that like playing Monopoly? I’ll throw in Boardwalk and two hotels.

Kerrie: I’ll ignore that and ask why would a land installment contract be the better choice? If an owner leases property to someone, the title to the property stays in the owner’s name. The tenant gets possession of the property in return for the payment of rent. As part of the deal, the tenant gets the option to purchase the property at a set price. The parties may agree that part of the rent is credited toward the purchase price. I think that would be the better protection for the owner/client.

Jim: As always, you are absolutely correct, my dear. It was a trick question. The agent proposed a “lease purchase” not a “lease with option to purchase.” The agent was asking for a contract whereby the buyer leases the property and also contracts his obligation to purchase the property, not just the option to purchase it.

Kerrie: Do you get the two hotels with that deal? There is no such thing as a “lease purchase.” It is either a lease or a purchase, it can’t be both.

Jim: I know; there is a lot of confusion about this. That’s why I suggested the land installment contract, which in Ohio is governed by statute and provides certain protections to the parties. Leases of residential premises are generally covered by the Ohio Landlord/Tenant Law, and to some extent the common law. The Landlord/Tenant law has no provisions regarding options to purchase, so that would be covered solely by common law.

Kerrie: And the common law comes from merry olde England. So instead of the two hotels you get a moat.

Jim: No, moats have been replaced by retention basins. You see them everywhere; usually filled with Canada geese. With a land installment contract the legal title to the property remains in the seller’s name and the buyer gets an equitable interest in the property that is recognized by law. The buyer is obligated to make the payments and can lose the property interest if the payments are not made. The protection to the buyer is that the seller must follow certain statutory steps to divest the buyer of the interest. If the buyer has not paid more than twenty percent of the purchase price or if the contract has been in effect for less than five years, the seller can file the equivalent of a simple eviction to cancel the contract. In that case the law provides that either party could be entitled to compensation based upon the fair rental value of the property.

Kerrie: Of course, if more than twenty percent has been paid or the contract has been in effect for more than five years, the seller must commence full foreclosure proceedings to divest the buyer of the interest. Which is why most land contracts never have a five year term. So why is a land contract better for our client?

Jim: The seller wants to sell and the buyer who has some money for a downpayment wants to buy. But with higher interest rates and tighter credit restrictions, the buyer cannot qualify for a loan. So as long as our seller does not need to cash out of the property right now, the sale can go through. The buyer pays the real estate taxes and gets the property insurance. The buyer can even take a deduction for interest paid, provided the parties follow the proper IRS procedures. There are some risks, however.

Kerrie: Right. If the seller has a mortgage, the land contract could be a breach of the due on sale clause that allows the lender to call in the loan.

Jim: That’s why the real estate agents use the term “lease purchase” because a lease may not be a breach of the due on sale clause. But if the lender were to look closely at the terms and see an obligation to purchase, the lender could call the loan anyway.

Kerrie: So it’s all semantics.

Jim: That’s the business we are in. I prefer to call it “word-smithing.”

Kerrie: Well, one thing is crystal clear. Both a lease with option and a land installment contract are complicated transactions where both parties should seek competent legal advice from a real estate lawyer.